Redwater Resources

Since our last post on the Redwater decision, the Alberta Court of Appeal, in a two-one decision, upheld the earlier judgment of Chief Justice Neil Wittman. The judgment was rendered by Justice Frans Slatter with Madam Justice Frederica Schultz concurring. Madam Justice Sheilah Martin’s dissent is the first ray of hope for the Alberta Energy Regulator (AER) and the Orphan Well Association (OWA) which has contested the Trustee in Bankruptcy’s right to disclaim unproductive oil wells. The trustee, Grant Thornton LLP, acting on behalf of Alberta Treasury Branches (ATB Financial), sought only to claim the productive wells. The ultimate outcome in this case is central to the relationship between oil and gas producers and lenders and to the financial viability of oil and gas producers, and in fact to the whole province’s economy. The case pits environmental values and interests against financial values and interests. Who cleans up when oil companies go bankrupt15-7-17 GM

In January 2013, ATB Financial entered into a credit arrangement with Redwater Resources, a publicly-traded junior oil producer. By mid-2014, after Redwater had experienced difficulties after a number of acquisitions and unsuccessful drilling initiatives, the company’s financial resources were depleted. In late 2014, when oil prices had begun a significant decline, efforts were made to sell its assets to allow repayment of the ATB loan in exchange for a deferral of interest payments until 30 April 2015. (Oil prices declined from about $105 U.S./barrel at the end of June 2014 to under $55 by the end of 2014.)

Given the oil price rout, the sales process did not attract prices sufficient to repay the secured loan. Redwater was also unsuccessful in finding another lender to pay ATB out. On 12 May 2015, a receivership order was obtained from the Court of Queen’s Bench under the Bankruptcy and Insolvency Act. Two days later, the Alberta Energy Regulator confirmed receipt of a notice that Grant Thornton had been appointed the Receiver. This letter to the Receiver was precisely drafted with prior jurisprudence in mind. For example the letter made clear that the “AER is not a creditor of the Licensee and does not assert a provable claim in the receivership. Rather, the AER has a statutory mandate to regulate the oil and gas industry in Alberta, which includes enforcement of the Acts, Regulations and Rules that it administers.” Furthermore:

The AER takes the position that Grant Thornton is legally and statutorily obligated to fulfill these obligations, and must do so prior to distributing any funds or finalizing any proposal to creditors, secured or otherwise. The AER is of the view that the current law in Alberta and federally supports this position and notes that suspension and abandonment address primarily public safety issues as opposed to environmental concerns, and constitute a carrying out of a duty owed by the licensee to the public.
While the AER is prepared to work with Grant Thornton to facilitate administration of the Licensee’s AER licensed assets, please note that any agreements made by Grant Thornton with third parties to transfer ownership of AER licensed wells, pipelines or related facilities do not effect the transfer of the associated AER licences. Transfer of AER licences requires application to and approval by the AER. When application for transfer is made, the AER assesses both the transferor’s and transferee’s ability to fulfil all applicable regulatory obligations then determines whether to approve the transfer of applicable license and approvals.

With that response, the gauntlet was thrown down in a struggle between one agent of the Crown in right of Alberta -ATB and another, the AER. The arguments were heard on December 16 and 17, 2015 in Calgary.

Chief Justice Neil Wittman’s judgment (19 May 2016) supported the applicant Grant Thornton and held that an operational conflict was imposed on the Trustee in Bankruptcy. In effect, Grant Thornton could not possibly comply with federal and provincial statutes at the same time. The paramountcy doctrine then applied meaning that the obligations of Grant Thornton to comply with provincial law were void.

The Alberta Law Review Article

In the second volume of the Alberta Law Review, 2016, Kelly Bourassa, Ryan Zahara and Chris Nyberg of Blake, Cassels, & Graydon LLP reviewed the treatment of restructuring orders after the Redwater decision. (Bourassa and Zahara represented ATB at the hearings at the Court of Queen’s Bench.) The authors were particularly concerned about the capacity of lenders, trustees in bankruptcy and the legal community to move forward to resolve bankruptcies in light of the ongoing legal uncertainty of the Redwater decision. Specifically they argued:

from a policy standpoint, allowing the AER’s claim for abandonment and reclamation obligations to take priority over a registered and perfected secured charge of a lender would create significant concerns in an already depressed energy market, especially where there is no way for lenders to take any kind of precaution to mitigate their risk. Such an approach would vitiate the entire purpose of the BIA priority scheme under section 14.06 and likely curtail further investment into an already desperate sector.

The authors provide helpful information about the Orphan Fund, the Orphan Well Association, Alberta’s oil and gas production licensing system, and the oil well abandonment process. Of interest is the fact that the OWA’s board of directors includes representatives from the Canadian Association of Petroleum Producers, the Explorers and Producers Association of Canada, the AER, and Alberta Environment and Parks. The authors emphasize that the OWA and the Orphan fund is “not an insurance scheme for insolvent licensees, but a safety net for the Alberta public.” (Emphasis added) They also observed that when the legislation was being discussed in 2007:

Albertans benefit from this safety net in two ways: (1) “[t]hey are protected from any future liability for orphan wells”; and (2) they know that the stewardship of the Alberta environment, including responsibility for orphan wells, is in the OWA’s hands.

The authors further note than in May 2013, the OWA began a process of increasing fees to oil and gas producers since they were concerned “that abandonment and reclamation obligations had historically been significantly underestimated.” This three year process was initiated “after extensive consultation with the Canadian Association of Petroleum Producers and other industry organizations.” So throughout this process, industry remained in control or at least appeared to remain in control. The changes included increases to “facility abandonment cost parameters for each well equivalent from $10,000 to $17,000.”

According to the OWA’s 2016-17 Annual Report, 185 wells were remediated during its fiscal year at a cost of $16.7 million or roughly $90,000 a well- seeming to suggest that the increase to $17,000 could be a slight under-estimation.

Bourassa et al then discuss the relevant jurisprudence in the case. Abitibi Bowater and Panamericana both dealt with environmental liabilities. In Panamericana, the Alberta Court of Appeal held that “the abandonment of wells is an expense inherent in the nature of the oil and gas industry and, the moment a well is drilled, a licensee necessarily incurs environmental liability.” The Supreme Court of Canada’s (SCC) review of the Alberta Appellate Court’s Panamericana decision recognized “that environmental orders could be caught by the definition of “claims,” but more importantly, it held that environmental orders that were claims could be compromised in insolvency proceedings.” The SCC also clarified that a license was tied to “real property” and hence a license was an interest in real property. This view was critical in Chief Justice Wittman’s decision and the appeal court.

Finally what is most interesting is the adaptation presently occurring in the oil financing business. Since the May 2016 Queen’s Bench judgment, the authors identified many cases where newly-appointed receivers have been granted specific powers to disclaim and renounce properties of the debtor. Of note is four other ATB receiverships which have included the power of disclaiming wells (Northpoint Resources Ltd (31 May 2016), Chinook Pipeline Inc (27 May 2016), Nordegg Resources Inc (13 July 2016) , and LGX Oil & Gas Inc (7 June 2016)). The article also notes that the “parties to the appeal of the Redwater proceedings have consented to an order which permits leave to appeal in exchange for the AER’s agreement to transfer the licences associated with the retained Redwater [wells] in the event of a sale.”

Dissenting Opinion of Justice Martin

In the opinion of the majority of the Alberta Court of Appeal, the Trustee’s inability to comply with federal bankruptcy law and provincial energy and environmental regulations lead to an operational conflict invoking the paramountcy doctrine. This meant that federal bankruptcy law trumped provincial resources and environmental jurisdiction. Madame Justice Martin took issue with her colleagues’ interpretation of the leading case law. All jurists held that the federal and provincial laws were valid exercises of the respective jurisdictions’ constitutional authority. But Justice Martin concluded that both regimes can co-exist.

In my view, the distinctive Alberta regulatory and licensing regime for oil and gas resources, which is wholly within provincial jurisdiction, creates generally applicable public legal duties, outside the scope of “claims provable in bankruptcy” as defined in the federal legislation.

Going on she argued that the construction that AER’s claims were “provable” under bankruptcy law was incorrect.

Most legal obligations have some compliance costs associated with them. However, the mere ability to assign a dollar value to compliance costs does not transform them into a monetary claim under the bankruptcy legislation. Since it “is presumed that Parliament intends its laws to co-exist with provincial laws,” courts should favour harmonious over conflicting interpretations of provincial and federal laws.

In speaking directly to the approach favoured by creditors’ counsel, namely a specific ability of the Trustee to disclaim property, she wrote:

To allow trustees in bankruptcy to pick and choose when they will comply with valid and generally applicable provincial law would be a power so extraordinary that it would require clear and express articulation. There is no such clear and express conferral of this power in the BIA. Nor should this power be inferred when to do so contravenes principles of statutory interpretation, co-operative federalism and the rule of law. Specifically, I conclude that the Trustee cannot disclaim the end of life licence obligations on the basis they are not real property. Further, while trustees have certain powers under the BIA, these are designed to protect trustees from personal liability, not confer on them the authority to disregard binding provincial legislation. The estate of the bankrupt remains liable for these end of life environmental obligations and they cannot be renounced by the Trustee.

On the matter of the AER having an interest in real property, Justice Martin made a distinction between the mineral license (real property) and the AER license which conveys no such right. She further cited an ATB internal document that expressly noted:

“[t]he costs for the borrower of abandoning a well and returning the well and land site to their pre-drilled condition can be significant. … Abandonment liability and calculations are required in third party engineering reports”. A third party engineering report that took into account Redwater’s abandonment obligations was prepared in this case. The answers to undertakings given by ATB’s representative also confirm that abandonment and reclamation liabilities are considered by ATB in its calculation of a customer’s borrowing base.

When reviewing amendments to the Bankruptcy and Insolvency Act addressing the priority of environmental claims, Parliament

Parliament struck a balance between the public’s interest in enforcing environmental regulations and the interest of third party creditors in being treated equitably. The creditor, who granted credit with full knowledge of the nature of the collateral available and the end-of-life obligations inherent in it, will take the benefit of more profitable portions of the debtor’s estate, while leaving the surface owner’s land in unsafe and less valuable condition. This sort of undesirable and unintended consequence should not happen unless there is no other available statutory interpretation.

Further she states

The continued application of the regulatory regime following bankruptcy does not determine or reorder priorities among creditors, but rather values accurately the assets available for distribution. The value of the debtor’s estate must take into account the end of life obligations associated with the licences that form a part of that estate. If this means that, in the end, there is less value available for distribution to the creditors, that is part of the bankruptcy scheme and the risk that the creditor takes when lending on the basis of the debtor’s assets, with their associated obligations.

…The licensee’s lenders are aware of the system. The occurrence of a bankruptcy should not enable lenders to avoid the system and access the value of specific licensed assets while ignoring the corresponding end of life obligations.

In one of her final paragraphs, Madam Justice Martin concludes:

The appellants argue that if Redwater can shed its end of life obligations, this would provide an incentive for many other similarly situated enterprises to organize their affairs to do the same, resulting in even more orphaned wells. They have a point, as the ability to avoid end of life obligations will not arise only on bankruptcy, but under the CCAA as well. This may encourage licensees to place wells with significant end of life expenses into one entity and separate that entity from other, more profitable, holdings. If that entity goes bankrupt or is re-organized, there is the fear that these public duties would be washed away from the entity and placed instead on others. There is unfairness if the entity is permitted to reserve and preserve any “assets” for itself and to avoid the costs of the public obligations assumed to gain access to the resource in the first place. The respondent and bankruptcy professionals before this Court argued that this fear is exaggerated. With respect, it is difficult to share their optimism. It is more realistic to assume that individuals will operate as rational economic actors who organize their affairs to maximize their own self- interest, within the limits allowed by law. If they are allowed to avoid or evade the end of life responsibilities attached to their licences, abandonment and reclamation, so necessary for the environment, would likely be among the first sacrifices made in times of fiscal difficulty.

If and when the appeal is heard, the decision of the Court may have long lasting implications for the regulated industry, Alberta and other environmental regulators, and of course lenders. It is unclear whether lending criteria have been significantly altered to include a fuller accounting of the environmental liability. This is a critically important area of the law, and it is unfortunate that Chief Justice McLaughlin will likely not be on the panel hearing the case.

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About albertarecessionwatch

Former Director, Institute for Public Economics, University of Alberta and currently Fellow of the Institute. Former executive with Alberta Treasury Branches. Worked for the Alberta government for 12 years with Federal and Intergovernmental Affairs and Alberta Treasury. Areas of focus: financial institutions legislation and policy, government borrowing, and relations with credit rating agencies. Ph.D in Political Science (Uof A), Masters of Public Administration and BComm. (Carleton University). Author of Politics and Public Debt: The Dominion, the Banks and Alberta's Social Credit. Presently working on study of Alberta provincial agency board appointments.